Swedish exit tax edges closer to reality

As I explained in the first quarter issue of the Cayman Financial Review, the Swedish government is considering a new tax on the outbound migration of capital. The proposal, which originated with the National Tax Agency, the Swedish equivalent to the IRS, is officially sold as a plug in a so-called loophole in the tax code through which Swedes and others with investments in Sweden, can move capital gains out of the country free of further taxation.
The new exit-tax proposal is being prepared by the Ministry of Finance for introduction to the Riksdag, the national parliament. Once introduced, it will have the status of a formal legislative proposal and be given procedural priority past other legislative initiatives. However, already before there is a formal bill before the Riksdag, the mere threat of this new tax has sparked controversy. On March 2, for example, members of the opposition in the Riksdag raised questions to Finance Minister Magdalena Andersson about the exit tax.

Ms. Andersson defended the exit tax as a measure to prohibit currently lawful tax avoidance. She also played down the consequences of the tax, a strategy that superficially seems to have defined the proposal itself. Here is how the official proposal explains the tax (author’s translation):

“An individual who emigrates and no longer has unlimited tax obligations in Sweden, or who attains residence in another country subject to double taxation treaty, shall be subject to a tax on capital gains accumulated up to the day before emigration. This rule shall only apply to persons who have been liable to taxation of capital gains for at least five of the past ten years prior to emigration, and whose taxable capital gains income is at least SEK100,000 [US$12,200].”

The tax would apply to shares, stock options and ownership of non-incorporated businesses. Notably, it would also apply to “other property not for personal use.”

No tax rate has been discussed yet, but it is possibly going to be 20 percent. This would put the exit tax on par with a complex set of tax regulations colloquially known to as the “three-twelve rules.” Under them, small business owners can pay as little as 20 percent in tax on dividends. This rate undercuts the normal 30 percent dividends tax rate, though is only available to incorporated businesses where fewer than five individuals own at least half the shares.

The exit tax is supposed to extend the same type of taxation to emigrating business owners. This argument for a level playing field rings hollow, considering the fact that the exit tax will apply more broadly and aggressively than existing business taxation.

A 20 percent tax rate may seem lenient, given the overall tax environment in Sweden and her European neighbors. However, before a business writes its first dividend check to shareholders, it has to pay a 22 percent corporate income tax. With yet another tax on dividends, the Swedish tax system – like so many others – is deep into the habit of double-taxing business revenue.

Emigration has been one way for Swedish business owners to avoid double taxation. This tax advantage is unusual in a country notorious for high taxes. For example, taxes on work-based income start with a local income tax in the 30 to 33 percent bracket. Almost 30 percent of all income tax payers also pay a national income tax of 20 to 25 percent. Bringing the marginal income tax close to 60 percent on the highest incomes.

Payroll taxes add 31.4 percent on top of wages and salaries. Taken together, income and payroll taxes create a substantial cost barrier for small business owners who wish to compensate themselves in the form of a salary. Capital income taxes at 30 percent (the aforementioned 20 percent being an exception) seem like a bargain by comparison.
The emigration opportunity has left a glimmer of hope of some tax leniency for those who invest in businesses in Sweden. An exit tax would shatter that hope.

Proponents of the tax are aware of its negative impact. In the debate in the Riksdag, the finance minister further tried to play down the impact of the tax by claiming that exit taxes already exist in other countries. However, if enacted, the Swedish exit tax would be one of the most extensive in the world. For example, its nearest equivalent in the United States only applies to Americans renouncing their citizenship.

The Canadian “deemed disposition” tax is more limited in scope than the Swedish proposal, restricting the tax base only to capital gains on top of original market value. The Spanish version is even more limited, applying only after ten years of tax residence and 15 years of physical residence. It also applies only to capital gains in excess of 4 million euros.

The Swedish tax would apply after five years of tax residence (ten years of physical residence) and already at capital gains of 10,000 euros.

Swedes leaving their native country are not the only ones who would be hit by the tax. Entrepreneurs and investors moving there for a few years to start a business or otherwise make investments would also be liable. Furthermore, the tax would significantly increase the cost for business owners who wish to make a generational transfer of ownership.

On Feb. 12, the daily financial Dagens Industri introduced its readers to Gunnila Blomberg, owner of Eleiko, a fitness equipment company. Wishing to retire, Ms. Blomberg wants to hand over her business to her children, some of whom live and work abroad to grow the business internationally. If the exit tax goes into effect, it will apply to the shares that Ms. Blomberg transfers to those of her children who live abroad at the time of transfer.

In other words, the tax would apply to Ms. Blomberg’s children as if they had sold their shares in the business, when in reality they are maintaining their family’s ownership.

The so-called loophole that this tax is designed to plug, is in reality a complicated but legal way to shield capital gains against taxes. A person leaving Sweden today can avoid paying capital gains taxes by using a third-party entity, often registered in Malta and created specifically for the purposes of exiting capital.

There is no credible information on how popular this exit method is; some estimates suggest that by closing this “loophole,” the Swedish government could collect an additional 100 million euros annually. It is important to note, though, that this number is based on the narrow definition of the tax currently being considered. For two reasons, it is unlikely that the exit tax, should it become law, would remain narrow.

To begin with, the Swedish exit tax would be comprehensive by European comparison. This raises the question whether or not part of its purpose is to serve as a harbinger for future exit taxes in Europe, and on the European Union itself. It is important not to be speculative about ulterior purposes behind taxes, but looking at the Swedish exit tax, it is impossible to escape the impression that it is supposed to do more than increase tax revenue.

For one, it flies in the face of the free-movement rhetoric that is so often used in support of European economic, social, political and cultural integration. Sweden being one of the most EU-friendly European nations, it is not inconceivable that this tax is a test run for future exit taxation at the EU level. After all, the purpose behind the EU’s black list of low tax jurisdictions is to use non-taxation means to discourage its residents from migrating capital to where capital is treated more favorably.

It would take a while for the EU to get to the point where a union-wide emigration tax would be politically palatable. However, it would make sense as an escalation from a blacklist. If the EU created its own exit tax, its member states could repeal their own. At that point, it would be helpful for the Eurocrats in Brussels to have a broad Swedish exit tax as a template.

Another reason to expect an expansive Swedish exit tax is the fact that real estate is not covered by the current proposal. This is odd: real estate investments are generally very profitable in Sweden. For example, average market prices of tenant owner housing properties doubled from 2005 to 2015, despite the deep recession of 2008 to 2010.

Furthermore, the political landscape in Sweden is favorable to broadly applied taxes presumed to hit “the rich.” Currently, the political composition of the Riksdag precludes the incumbent Social Democrat-Green Party coalition government from relying on a consistent legislative majority. To move bills they often need support from the former communist Left Party. Since this small but resilient party casts itself as the “true” socialists, they consistently pull legislative compromises in the far-left direction.

Should the incumbent Social Democrat prime minister be able to form another cabinet after the September elections, he is likely going to have to rely more heavily on the Left Party. The Greens, his current coalition partner, have been tarnished by political mistakes and fallen from grace to gutters in opinion polls.

With a stronger radical left, another Social Democrat administration will have to find new ways to further raise taxes. A broadly defined exit tax would easily make the list.